I have said in the past to "Beware the Economist who is seeking guidance from the stock market as to the state of the economy. These creatures make lousy economists and worse money managers."

Jim Welch takes this a step further, explaining the "message of the markets:"

"Over the many years I have been following and learning about the economy and financial markets, I have heard comments used repeatedly by presumably knowledgeable experts as they discuss various markets. People will say the markets are a discounting mechanism, and that markets anticipate events, as when stocks bottom before an economic recovery. Some people will go so far as saying that a particular market is telling us a specific outcome is coming based on how that market is trading.

After listening to these comments when I was younger, I too believed that “markets” were indeed imbued with a special instinct about the future. If I could just learn to listen to them, I would learn something I wouldn’t get out of a financial newspaper or research report. One of the CNBC anchors has even published a book entitled “The Message of the Markets”. Of course, the message is always clearer with the benefit of hindsight. I know I would have done better in school, if I could have just taken all those tests, after having already taken them once!

In 1982, the stock market had spent 16 years going nowhere, which prompted Business Week to publish a cover story entitled “The Death of Equities.” Somehow they didn’t get the market’s message that a 1,200% increase in 18 years was about to commence. When the stock market crashed 22% in one day in 1987, almost double the decline on Black Tuesday in 1929, was the market telegraphing a coming depression? And when the Nasdaq zoomed past 5000 in 2000, was it proclaiming that we had arrived in a “New Paradigm” Paradise? A list of examples showing that markets are always wrong at important turning points could be a very long list.

Needless to say, I don’t subscribe to the notion that markets ‘know’ much about the future. Markets are a reflection of recent trends and what a majority of investors have come to believe at that moment, in response to the recent trend. And, when a majority of investors are fairly certain of an outcome, the probabilities rise that something other than what is expected is likely to occur." (emphasis added)

-E. James Welsh

We have said this previously, but it bears repeating: The crowd is right much of the time. However, the crowd can easily become an unthinking mob. They tend to be wrong at the worst possible moment, most especially at turning points.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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"We don’t see things as they are, we see them as we are." -Anais Nin

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